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Sequence of Returns Risk & the Lost Decade
Illustrative only — not a forecast. Investments can lose value; annuity guarantees depend on contract terms and the issuing insurer.
Retirement changes the job of your money. While you are working, a market decline can be painful but you may still have time to keep contributing and wait for a recovery. Once you are withdrawing every month, the order of returns matters because selling after losses can leave fewer shares available for the recovery.
The retirement-income problem in one sentence
You cannot control the sequence of market returns. You can control which dollars are forced to depend on that sequence.
What is sequence-of-returns risk?
Sequence-of-returns risk is the risk that poor investment returns occur early in retirement while withdrawals are also coming out of the portfolio. The same long-term average return can produce very different retirement outcomes depending on when the bad years occur and how much is being withdrawn during them.
Why does the beginning of retirement matter so much?
A market decline by itself is not the whole problem. The combination of a decline and ongoing withdrawals can be more damaging. If shares must be sold after prices fall, more shares may be needed to create the same amount of spending money. Those shares are no longer present when the market eventually recovers.
The Lost Decade is a useful retirement lesson
The 2000s included two major bear markets and long stretches in which stock investors had to wait for recovery. The lesson is not that stocks are bad or that retirees should abandon growth assets. It is that a retiree who must fund essential expenses from a volatile portfolio has a different problem than an accumulator who can leave the account untouched.
Accumulation and retirement are different games
| While accumulating | While withdrawing |
|---|---|
| You may continue contributing during declines | You may be selling assets during declines |
| Time can help a portfolio recover | Monthly expenses continue while you wait |
| Lower prices can make new contributions more productive | Lower prices can force more shares to be sold for the same withdrawal |
| Volatility is mostly an account-value issue | Volatility can become a cash-flow issue |
Traditional ways to reduce sequence risk
There is no single solution. Common approaches include holding a cash reserve, changing spending during down markets, holding more high-quality fixed income around retirement, delaying retirement or Social Security when appropriate, and creating dependable income that does not require selling market assets each month.
A different way to frame the problem: build an income floor
Instead of asking the investment portfolio to produce every retirement paycheck, first identify the expenses that must be paid regardless of what the market is doing: housing, food, utilities, insurance, healthcare and other essential monthly needs.
Then compare those expenses with dependable income already available from sources such as Social Security and pensions. If there is still a gap, an appropriately selected annuity can be considered as one tool for creating additional contractual income.
Income assets do the income job. Growth assets do the growth job.
The objective is not necessarily to move everything out of the market. It can be the opposite: cover the essential income gap with dependable sources so the remaining portfolio has less pressure to be sold during a bad market and can stay positioned for long-term growth, inflation defense, discretionary spending and legacy goals.
What does “create your own pension” mean?
It is shorthand for using an insurance contract to create a predictable stream of retirement income for some portion of your essential expenses. It is not a government or employer pension, and the guarantees depend on the specific annuity contract and the claims-paying ability of the issuing insurer.
The correct amount is not automatically 100% of the portfolio. The useful question is: How much of your monthly lifestyle do you want to depend on market withdrawals?
What if the market does well?
An income-floor strategy does not require giving up all market growth. If only the portion needed to support essential income is allocated to guaranteed-income tools, the remaining assets can stay invested according to the investor’s goals, risk tolerance and broader financial plan.
What are the tradeoffs?
| Potential benefit | Tradeoff to consider |
|---|---|
| Less dependence on selling stocks for essential bills | Capital committed to an annuity may have reduced liquidity |
| More predictable monthly income | Contract features, fees, surrender periods and payout choices vary |
| More freedom to leave growth assets invested through downturns | Growth assets still fluctuate and can lose value |
| Potential lifetime income | Inflation protection and legacy value depend on the specific design |
Questions I would answer before using an annuity for the income floor
- What are your essential monthly expenses?
- How much is already covered by Social Security or a pension?
- How much liquidity should remain outside any annuity?
- Is the goal income now, income later, or accumulation first?
- How much market exposure do you want to keep?
- What happens to a spouse if one person dies first?
- How should qualified retirement money and required distributions be coordinated?
- How important are inflation protection and legacy value?
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This page explains retirement cash-flow concepts, not a prediction of future market returns. Historical market periods do not repeat in the same way. Annuity guarantees, liquidity, income options and tax treatment vary by contract and carrier. King Life provides insurance guidance and coordinates with tax, legal and investment professionals where appropriate.